Is it time to buy QBE?

With broker Credit Suisse reportedly upgrading QBE Insurance (ASX: QBE) to an ‘outperform’ rating this week, it would appear to be a good time to revisit the outlook for the global insurer.

QBE’s share price has now underperformed the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) over one, five and 10 years. With the share price currently around the $14.80 mark and having traded in a range from a low of $10.02 to a high of $17.53 in the past 12 months – at a time when many other stocks are pushing new highs – QBE is an unloved and underperforming stock.

Timing certainly makes a difference in investing, particularly over shorter time frames. However over the longer term the value-accretive or value-destroying underlying performance of a company becomes much more pronounced. Interestingly, Insurance Australia Group (ASX: IAG), which has outperformed both QBE and the index over one and five years, has underperformed both QBE and the index over 10 years.

Two factors stand out in contributing to QBE’s current predicament. Firstly, the company (like most insurers) is suffering from a low interest rate environment, which makes earning a decent return on funds very difficult. Secondly, the company has experienced a number of issues within its North American division – arguably these are mainly based on poor managerial decisions, including an acquisition program that extended the company too far. However some industry conditions have been outside of QBE’s control.

While there is little QBE can do to shield itself from low interest rates, past managerial acquisition binges or general tough industry conditions, management has moved to effect change where it can. The launch of an ‘Operational Transformation Plan’, which involves significant cost cutting and efficiency measures, should harness synergies and create a leaner organisation and importantly, annualised cost savings of around $250 million.

Foolish takeaway

As a rule of thumb insurance companies should be valued with consideration given to their higher risk profile than your average industrial company. Whilst on current earnings QBE probably looks close to fair value, after looking forward a few years and adjusting for the cost-out program and allowing for perhaps a slight normalisation of interest rates, the valuation starts to get quite appealing.

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Motley Fool contributor Tim McArthur owns shares in QBE Insurance.

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